How to Do Trend Analysis

Investors will likely adopt any strategies that yield positive returns on investment, especially when it comes to stock investing. In stock investing, investors need to know how the market works. So, they may often ask themselves questions like “What drives the market?”. One crucial aspect of understanding how the market works can be found in a certain kind of market analysis called “trend analysis”. Before you grasp what, this means, it is important to know some basics like learning about market trends. 

What is a market trend? 

Market trends are often analysed by traders who wish to make their trading profitable. Trend analysis has its basis in the understanding of market trends. In simple terms, a market trend reflects the direction of the market based on the movement of stock prices. The prices of stocks or shares move in any of two directions: upwards or downwards. Share prices shift in an upward direction when the market sentiment is bullish and plunge downwards when the markets are bearish. Typically, the prices of shares don’t move in a straight direction as share prices are prone to volatility, especially in the short term. Investors must consider a certain time frame if they wish to depend on stock price shifts determining a trend. 

Investors can decide on a market trend and analysis when they consider price movements during a longer period. What this means is that the longer the movement of a trend, either upward or downward, the simpler it is to identify that trend. 

Understanding Trend Analysis 

Trend analysis in the share market is a specific process that permits investors to predict stock price shifts in the future. They achieve this by analysing market trends. In trend analysis, historical data is analysed and studied, so that investors can easily estimate market movements in the long term. Hence, via trend analysis, investors may be able to make predictions about certain sectors expanding their position or declining in terms of their growth. 

The process of trend analysis involves the analysis and evaluation of vast amounts of data. In other words, trend analysis aids investors in comparing the performance of a business or company so that they get some clues as to whether the business operations of the said company will have good prospects or not. In this way, investors may decide to invest in a company or decline investment after doing some due diligent trend analysis. 

Also known as horizontal analysis, trend analysis is especially important where the investment in shares or stocks is concerned.  Trends in the share market inform investors about a company and investors may decide to invest in that company’s stock or give it a miss. Besides trend analysis telling investors about how individual companies and their operations are performing, the method also gives investors an idea of particular sectors that show positive or negative trends. Once investors get a grip on what trend analysis means, they can explore the different strategies that can be used to employ trend analysis. 

What are the different types of trend analysis strategies? 

There are some commonly used strategies by investors while they do trend analysis. These are listed and explained below: 

• Moving Average 

The moving average, commonly known as MA, is a stock indicator used by traders when they engage in technical analysis. The primary purpose of calculating moving averages is to decrease the effect of price fluctuations in the short term, over a particular period. Traders who employ such a strategy enter long positions when a short-term moving average shifts above a long-term moving average. In contrast, when a short-term moving average goes below a long-term moving average, short positions are entered into by investors. The trend analysis explanation of this strategy can be understood with the example of the Tata Motors chart below: 

From the chart shown above, you can see that traders opt to enter a long position if the short-term moving average shifts above the long-term moving average. 

• Momentum Indicators 

Momentum indicators under the category of trend analysis are used to detect a stock price’s strengths and weaknesses. In this strategy, the momentum estimates the rate at which the stock’s price goes up or down. Typical examples of momentum indicators include MACD or moving average convergence divergence, and RSI, or the relative strength index. 

This strategy under trend analysis involves the trader entering a long position if the price of a stock tends to move up or down with excessive momentum. Given this, investors who follow the strategy are prone to square off long positions when the stock of a company loses momentum. Commonly, most traders tend to employ the relative strength index when they use this strategy. From the same stock price chart of Tata Motors shown in the previous section, you can see that the shares of the company are trending higher with an increase in momentum. 

• Chart Patterns and Trend Lines 

Trendlines can be defined as a sequence of curves and lines that technical analysis uses to identify patterns in the prices of stocks. In market trend analysis, traders use this technique to find out support and resistance lines on a stock price chart. Investors who follow this method of trend analysis enter long positions if the shares of a given company are trending higher. Furthermore, this method permits traders to place stop-loss orders below resistance levels or support levels, that is, the main trendline. You can understand this from the price chart of Tata Motors shown below: 

In the chart, you can see when the shares of the premier auto company are trending higher. In such a case, investors can place a stop-loss order below the support area or at the support area. 

Formula for Trend Analysis 

There is no specific single formula for analysing trends in the share market. This is because the particular methods used to analyse trends may vary according to the data that is analysed and the specific goals that the analysis aims to achieve. However, there are some key statistical measures employed in trend analysis, and these aid in locating trends and patterns within given data. These measures include linear regression, moving averages, and measures to find correlations. 

Use of Trend Analysis

The uses of trend analysis are relevant for traders in the stock market. These are the key uses (translating to the advantages of trend analysis) of trend analysis: 

• Trend analysis aids traders in the identification of opportunities to purchase and sell securities in the financial markets.
• Trend analysis is useful in the detection of potential risks or danger signs that a market or security may be on the way to a downturn. 
• Trend analysis provides potentially reliable insights into the psychology of the markets as well as the momentum of the markets. 

Conclusion

Traders describe trend analysis as the effective study of data that is used to efficiently identify trends or patterns in the prices of stocks in the financial markets. Hence, this way of analysing stock data is useful for making trading and investing decisions. Typically, this kind of analysis helps in understanding how a specific security is performing over a set period. If you indulge in trend analysis, you may be able to decide whether you should buy a specific stock in a particular sector, sell it in the short term, or hold on to it for long-term investment. The beauty of trend analysis as a tool for decision-making in investment is that it incorporates various sources of data including financial statements, price charts, market data, and economic indicators.